If you’ve just gone through the stress of filing a bankruptcy, you may think you’ve completely exhausted your options for borrowing ever again. However, depending on the market value of your home and your personal circumstances, there may still be a light at the end of the tunnel in the form of a home equity loan.
Home equity loan vs. home equity line of credit (HELOC)
There are several key differences to keep in mind when applying for a loan or line of credit that uses the equity in your home as collateral. Regardless of the one you choose, both options could put you at risk of losing your home if you default on your mortgage payments.
A home equity loan provides you with a fixed amount of money up front that you pay back over a period of time.
In contrast, a home equity line of credit, or HELOC, works just like a credit card from which you can borrow what you need. Interest is only charged on the funds you actually withdraw from the line of credit, rather than the entire amount to which you have access whenever you may need it.
The disadvantage with choosing a HELOC is that the interest rate can vary, and it’s not always in your favor. In contrast, a home equity loan is much more predictable: The interest rates are fixed and the same amount of payment is required each month.
At the time of writing, the variable rate for a HELOC ranged from 5.20% annual percentage rate to 8.60% APR, depending on factors such as changes in the prime rate, a credit score under 730, a loan-to-value (LTV) ratio above 70% or a credit limit below $100,000. In comparison, home equity loans were, at the time of writing, offered at an APR of 5.49% over 10 years.
What loans are available if you have filed for bankruptcy?
Even after filing for bankruptcy, you may be eligible for a type of home loan that is insured through the Federal Housing Administration. Because the government guarantees it will repay these loans even if borrowers stop making payments, banks are more willing to provide mortgages to candidates they would not normally consider. FHA loans assigned after Jan. 1, 2019 and in high-cost areas have increased their minimum and maximum limits to $314,827 and $726,525, respectively. You can search for loan limits applicable to your county here.
Borrowing after a Chapter 7 bankruptcy filing
If you filed the most common bankruptcy for individuals, a Chapter 7 bankruptcy, where property is liquidated and sold to pay off any remaining debt, you will need to wait two years before you can apply for an FHA loan. The waiting period begins when you receive the court order releasing you from liability for your debts, otherwise referred to as a discharge. However, if you are able to demonstrate extenuating circumstances that led to the bankruptcy — such as a natural disaster, serious illness or death of a breadwinner in the family — this waiting period may be shortened to 12 months, according to FHA guidelines.
Minimum waiting periods for other types of lending products include four years for a conventional mortgage, two years for a VA loan for eligible military veterans and service personnel and three years for a USDA mortgage. This may be in addition to any other waiting periods required by individual lenders.
Regardless of the length of your waiting period, you must be able to show a clean slate. This involves not taking on any additional debt, re-establishing good credit and demonstrating that you have a stable job or source of income.
Borrowing after a Chapter 13 filing
The Chapter 13 bankruptcy allows sole proprietors, wage earners and self-employed individuals with a regular source of income to keep their property when filing for bankruptcy. They must work with a trustee to repay a portion of their debts through a three- to five-year payment plan; any debts left over are then discharged. (Another alternative to Chapter 7 relief that also allows debtors to avoid liquidation and remain in business is the Chapter 11 bankruptcy, which applies to individuals engaged in corporations and other partnerships.)
If you filed a Chapter 13 bankruptcy, you could still buy a home within this five-year period of time by applying for an FHA loan. To be eligible, you will have to show at least one year of satisfactory and timely payments to the payment plan and get written approval from the court trustee.
Tips on repairing credit after bankruptcy
Bankruptcy is more common than you might think. According to statistics released by the Administrative Office of the U.S. Courts, 779,828 bankruptcies were filed for the year ending March 31, 2018. However, there are a number of ways to repair your credit, improve your finances and become a valued borrower following a bankruptcy. In fact, a recent Lending Tree study showed 43% of people who filed for bankruptcy have a credit score of 640 or higher within the first year of taking certain proactive steps.
Here are some of those steps to help you start the credit-rebuilding process and get ready for homeownership again.
Order an updated credit report
Ensuring your record is accurate and up to date could pay off in the long run. According to a study by the Federal Trade Commission, 20% of consumers see an increase in credit scores after disputing errors found on their record.
All three of the nationwide reporting companies, TransUnion, Equifax and Experian, are required by law to provide you a free annual credit report every 12 months. Order yours to check for any errors your creditors may have made.
Pull out the piggy bank
Start an emergency fund large enough to cover sudden expenses and pay bills on time without needing to rely on a credit card. Saving money regularly also will help you put together the down payment required for an FHA loan as well as for other related costs.
Use a secured credit card regularly and responsibly
Getting another credit card may seem counterintuitive at first, but it will help you re-establish good credit if you can use it responsibly. It involves putting down as a deposit an amount of money equal to the limit available on the card. So if you want to borrow $100, you will first have to deposit an additional $100. Over time, as you make payments regularly and in full, you will improve your credit score, get your deposit back and eventually become eligible for a regular, unsecured credit card again.
The rule of thumb is to never use more than a third of the funds available on the card, said Thomas Rindahl, a financial adviser with TruWest Wealth Management in Arizona.
Rindahl recently recommended a secured credit card to a client whose daughter had with poor credit. “Rather than giving her daughter the funds outright to pay off her debt, I suggested she instead lend her the money to take on a secured loan,” he said.
“That way, as the daughter paid off the loan, she was also building up her own credit enough to qualify to buy a house.”
Avoid multiple new accounts or hard inquiries into your credit score
Limit your applications for credit. About 15% of your FICO score calculation is made up by the average age of all your credit accounts. If you open too many new accounts in a short period of time, it looks as if you rely too heavily on borrowing to pay your expenses and that may subsequently lower your credit score.
Add yourself to someone else’s card as an authorized user
If your scores are low, ask a family member with well-managed credit cards if they can add you as an authorized user on their accounts. “You don’t have to actually use the card to build up your credit score,” said Jacob Lunduski, a lead credit analyst at Credit Card Insider in New York.
“As long as the card is used responsibly, it will add a new record of on-time payment to your credit reports and help offset some of the negative damage.”
Points to remember
Be mindful of bad financial habits. Take a step back to evaluate self-destructive behaviors that may have played a role in your need to file for bankruptcy. Make an effort to change this as you walk the path of rebuilding your credit score. Ensuring you get into the habit of saving on a daily basis will build up a rainy-day fund that can help you face unexpected expenses without compromising your future home equity loan or HELOC.
Seek professional financial advice to determine whether a home equity loan or HELOC makes sense. Make sure you factor in the current environment of rising interest rates and new tax laws in 2019 that are eliminating homeowner tax breaks, such as the home equity interest deduction.
While filing for bankruptcy can have a significant adverse effect on your credit score, you still can be eligible for homeownership, loans and interest rates at the same terms as everyone else.
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